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Economic appraisal glossary and abbreviations

This page provides definitions of words commonly used throughout the appraisal process.

Glossary

A

Additionality An impact arising from an intervention is additional if it would not have occurred in the absence of the intervention. A project is regarded as fully additional if, without intervention, it would not happen at all. However, additionality may be partial - for example, if an activity is undertaken on a larger scale, or earlier, or to a higher standard, or within a policy target area, as a result of public sector intervention. In cases of financial assistance, additionality should be assessed to establish that the proposed assistance is the minimum necessary.

Affordability An assessment of whether proposals can be paid for in terms of resources, cash-flows and funding. It involves setting out the capital and resource DEL impacts of proposals year by year over time; showing (separately) the corresponding year by year cash flows; and indicating the intended sources of funding.

Annually Managed Expenditure (AME) Expenditure that is relatively volatile and largely demand-led that cannot reasonably be given firm, multi-year limits in the same way as DEL. AME includes social security benefits, local authority self-financed expenditure, debt interest, and payments to EU institutions. Because a shorter-term view is required in such areas, a separate annual AME spending limit is imposed. See also Departmental Expenditure Limit (DEL).

Appraisal The process of defining objectives, examining options and weighing up the relevant costs, benefits, risks and other factors to inform an investment decision. Also known as Economic Appraisal, Expenditure Appraisal or Investment Appraisal.

Assessment A broad umbrella term for appraisals, evaluations and more specific forms of expenditure appraisal such as affordability analyses or additionality tests.

B

Base Case The best estimate for each option of how much it will cost in economic terms, including allowance for risk and optimism.

Baseline Option A benchmark option included so that the VFM of the alternative 'Do Something' options may be judged by reference to current or minimum service provision. Usually a ‘Do Nothing’ (that is, status quo) option or ‘Do Minimum’ option. Sometimes called the ‘base case’ option, but see above definition of base case.

Benefits Management A structured approach to ensure maximum benefits are delivered, that involves identifying, planning, measuring and tracking benefits from the start of a project until all its benefits are realised. The term ‘benefits management’ is often used interchangeably with the term ‘benefits realisation’.

Benefit Profile A full description of a projected benefit including details on measures, ownership, responsibilities, dependencies and timing. Each anticipated benefit and dis-benefit should have a one page benefit profile. Defining benefit profiles is a fundamental step in benefits management as it is at this point that the practical considerations of benefit realisation are considered.

Benefits Realisation Plan A management tool to monitor, track and manage the collective set of benefits associated with a project. The key activities (measurements, evaluations etc) from each benefit profile should be drawn together to form a consolidated plan to help keep track of what needs to be done, when and by whom, to manage the successful realisation of benefits.

Business Case A business case provides the rationale for undertaking a programme or project, usually presented within a well-structured document such as a Strategic, Outline or Full Business Case.

C

Capital budget A department's capital budget covers capital expenditure. The capital budget is divided into DEL and departmental AME. The capital budget is not a control total; capital DEL is a control total and capital AME is a planning total. (See Departmental Expenditure Limit (DEL), Annually Managed Expenditure (AME) and Resource Budget)

Contingent Valuation This involves asking people directly how much they would be willing to pay for a good or service, or how much they are willing to accept to give it up.

Commensurate Effort (or Proportionate Effort) The concept that the effort to be put into appraisal or evaluation should be in proportion to the scale or importance of the proposal.

Contingency An allowance of cash or resources to cover unforeseen circumstances.

Conventional Procurement Option The option of procuring services using traditional public sector procurement methods rather than by PFI or another form of PPP. (See PFI and PPP).

Cost Benefit Analysis (CBA) Analysis that seeks to quantify all of the costs and benefits of a proposal in monetary terms, including items for which the market does not provide a satisfactory measure of economic value.

Cost-Effective Delivers a given level of service at least cost. More generally, delivers services at an optimal ratio of benefit to cost.

Cost-Effectiveness Analysis (CEA) Analysis that compares the costs of alternative ways of producing the same or similar outputs.

Cost of Capital The cost of raising funds (expressed as an annual percentage rate).

Cost Utility Analysis (CUA) A hybrid of CBA and CEA in which cost-benefit ratios are measured by comparing costs expressed in monetary terms with benefits expressed in other units - for example, cost per QALY (quality-adjusted life years).

Crowding Out The extent to which an increase in demand occasioned by government policy is offset by a decrease in private sector demand.

D

Deadweight Expenditure to promote a desired activity that would in fact have occurred without the expenditure. In terms of financial assistance, deadweight is any excess over the minimum assistance required to secure a project.

Departmental Expenditure Limit (DEL) Spending which is planned and controlled on a three year basis in Spending Reviews. The DEL is the annual spending limit imposed on a government department arising from its agreed, longer-term financial settlement with DoF. Normally categorised into capital DEL and resource DEL and fixed for three years ahead. See also Annually Managed Expenditure (AME).

Depreciation is also termed capital consumption. It is a measure of the reduction in value of an asset due to the effects of wear and tear, aging and use. The value of an asset is assumed for accounting purposes to decrease or ‘depreciate’ each year. The amount by which to write down an asset in a balance sheet to reflect depreciation can be estimated in a number of ways. The most common approaches are:

straight line depreciation assumes that the asset loses an equal amount of its value each year over its expected lifetime

decreasing balance depreciation assumes that the asset loses a constant percentage of the value remaining each year after deducting previous write-downs, until it is finally scrapped and written off

accelerated depreciation assumes that the amount of depreciation taken each year is higher during the earlier years of an asset’s life – it is used when an asset is expected to be much more productive during its early years, so that the depreciation more accurately represents how much of an asset’s usefulness is being used up each year

Diminishing Marginal Utility The tendency as extra units of any commodity or service are used up or ‘consumed’, for the satisfaction provided by those extra units to decline.

Discounting The conversion of future costs or benefits to present values using a discount rate. It is often necessary to compare options that will impact over a period of years into the future, which raises the question of how future cost and benefits should be valued in today's terms. Normally people prefer to receive cash sooner rather than later, and pay bills later rather than sooner. This is true even after allowing for inflation. For an individual this time preference may be indicated by the real interest rate on money lent or borrowed. In the public sector, likewise, we reflect social time preference by giving more weight to earlier than to later costs and benefits. This process of “discounting” is usually given effect by applying a "discount rate" to future costs and benefits.

Discounted Cash Flow (DCF) A way of estimating the value of an investment in today’s money by adjusting future returns to get their present value. A technique for appraising investments, involving calculation of a Net Present Value (NPV) by discounting a stream of cash-flows over time. It reflects the principle that the value of costs and benefits in present day terms declines over time.

Discount Rate The annual percentage rate at which the present value of a future pound, or other unit of account, is assumed to fall away through time. It is currently set at 3.5% pa in real terms. Mathematically, a discount rate is the opposite of a compound interest rate. The discount rate defines how rapidly the value today of a future pound declines through time in real terms, just as a real rate of interest determines how fast the real value of a pound invested now will increase over time.

Displacement The degree to which an increase in productive capacity promoted by government policy is offset by reductions in productive capacity elsewhere.

Do Minimum Option An option where government takes the minimum amount of action necessary. Used as a benchmark option in some appraisals.

Do Nothing Option The status quo option i.e. the option of carrying on with the current arrangements. Does not mean literally doing nothing. Used as a benchmark option in many appraisals.

Do Something Option An option that provides enhanced services by comparison to the benchmark ‘do nothing’ or ‘do minimum’ baseline option.

E

Economic Appraisal See Appraisal

Economic Cost (or Opportunity Cost) The value of a resource in its most productive alternative use.

Economic Efficiency A term that refers to the optimal production and consumption of goods and services. An investment may be considered economically efficient if it offers net benefits to the economy.

Economical Uses resources carefully to minimise expense, time or effort.

Effective Delivers a successful outcome and meets objectives as fully as possible.

Efficient Delivers a given level of service for minimum input of cost, time or effort; or obtains maximum benefit from a given level of input.

Equitable Delivers services and uses resources in a manner that is fair and equal.

Evaluation Retrospective analysis of a project, programme, or policy to assess how successful or otherwise it has been, and what lessons can be learnt for the future.

Existence Value The value placed by people on the continued existence of an asset for the benefit of present or future generations. The latter is sometimes referred to as bequest value.

Expected Value The weighted average of all possible values of a variable, where the weights are the probabilities.

Expenditure Appraisal A very broad umbrella term for assessments including appraisals, evaluations, affordability analyses, viability assessments and so on.

External Costs or Benefits The non-market impacts of an intervention or activity which are not borne by those who generate them.

F

Full Business Case (FBC) A business case containing a final review of value for money, affordability and achievability, usually developed following a procurement and documented prior to financial closure. See also Strategic Outline Case and Outline Business Case.

G

GDP Deflator An index of the general price level in the economy as a whole, measured by the ratio of gross domestic product (GDP) in nominal (that is, cash) terms to GDP at constant prices.

Gross Domestic Product (GDP) is a measure of the size of an economy. GDP per capita is often used as an indicator of the standard of living in an economy.The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time. It is equivalent to the sum of value added at every stage of production of all final goods and services produced within a country in a given period of time. The most common approach to GDP measurement is the expenditure method: GDP = consumption + investment + government spending + (exports - imports).

Gross Value Added (GVA) is the difference between output and intermediate consumption for any given sector/industry. That is the difference between the value of goods and services produced and the cost of raw materials and other inputs which are used up in production.

H

Hedonic Pricing Deriving values by decomposing market prices into their constituent characteristics on the premise that the price of a good or service is related to its individual characteristics. For example, the price of a vehicle reflects a number of its characteristics - comfort, style, accessories, fuel economy and so on. Thus the individual characteristics of the vehicle may be valued by assessing how the price people are willing to pay for it changes when the characteristics are changed.

I

Information Asymmetry Differences in information held by parties to a transaction where this information is relevant to determining an efficient contract or a fair price or for monitoring or rewarding performance.

Impact Assessment A form of multi-criteria analysis that involves description, quantified where possible, of all the significant impacts of a proposal (for example, in terms of health, equality and environmental impact), and of how they are distributed between those affected.

Implementation The activities required during the period after appraisal to put in place a policy, or complete a programme or project, at which point ‘normal’ service is achieved.

Internal Rate of Return (IRR) The discount rate that would give a project a present value of zero.

Irreversibility May be an issue when an option would rule out later investment opportunities, or would use resources now that might subsequently be preferred for a more important use later.

M

Market Failure An imperfection in the market mechanism that prevents the achievement of economic efficiency.

Market Value The price at which a commodity can be bought or sold, determined through the interaction of buyers and sellers in a market.

Marginal Utility The increase in satisfaction gained by a consumer from a small increase in the consumption of a good or service.

Monte Carlo Analysis A technique that allows assessment of the consequences of simultaneous uncertainty about key inputs, taking account of correlations between these inputs.

Moral Hazard An example of information asymmetry where a contract or relationship places incentives upon one party to take (or not take) unobservable steps which are prejudicial to another party.

Multi Criteria Analysis Term for techniques (such as impact assessment and the weighted scoring method) for making a comparative assessment of options, taking account of several criteria simultaneously. Mainly used to assess impacts that can not be readily quantified in money terms.

N

Net Present Value (NPV) NPV is a primary investment decision criterion. NPV is defined as the difference between the present value of a stream of benefits and that of a stream of costs. A positive NPV occurs when the sum of the discounted benefits exceeds the sum of the discounted costs. A negative NPV is usually called a Net Present Cost (NPC). The decision rule is to select the option that offers to maximise NPV, or minimise NPC. This is subject to assessment of those impacts that can not be valued in money terms. NPV takes account not only of social time preference through discounting, but also, by combining capital and recurrent cost and benefits into a single present day value indicator, enables direct comparison of options with very different patterns of costs and benefits over time.

The Northern Ireland Guide to Expenditure Appraisal and Evaluation (NIGEAE) is the primary guide for Northern Ireland Departments on the appraisal, evaluation, approval and management of policies, programmes and projects. Its principles are broadly similar to those applied elsewhere in the UK, but it is tailored more specifically to suit the needs of Northern Ireland Departments, taking account of local policies and institutional arrangements. NIGEAE is web-based guidance which is located in the Finance section of the DoF website.

O

Opportunity Cost See Economic Cost.

Optimism Bias The demonstrated systematic tendency for appraisers to be over-optimistic about key project parameters, including capital costs, operating costs, works duration and benefits delivery.

Option Appraisal See Appraisal.

Option Value The value of the availability of the option of using an environmental or other asset (which in this context is usually non-marketed) at some future date.

Outline Business Case (OBC) A detailed assessment of value for money, affordability and achievability including a full economic appraisal and other key management information. Designed to inform an investment decision and (for procurement projects) completed prior to proceeding to procurement. See also Strategic Outline Case and Full Business Case.

P

Post Project Evaluation A post-implementation review of a project’s success.

Precautionary Principle The concept that precautionary action can be taken to mitigate a perceived risk. Action may be justified even if the probability of that risk occurring is small, because the outcome might be very adverse.

Present Value The present day value of a future stream of costs or benefits. Calculated by discounting a stream of future costs or benefits. (See also Net Present Value, Discount Rate).

Price Index A measure of the amount by which prices change over time. General price indices cover a wide range of prices and include the GDP deflator and the Consumer Price Index (CPI). Special price indices apply to one commodity or type of commodity.

Private Finance Initiative (PFI) A particular form of Public Private Partnership (PPP) by which a public sector organisation contracts with a private sector entity to construct a facility and provide associated services of a specified quality over a sustained period.

Proportionate Effort See Commensurate Effort

Proposal An idea for a policy, programme or project that is under appraisal.

Public Private Partnership (PPP) A structured arrangement between the public sector and a private sector organisation to secure an outcome delivering good value for money. Includes PFI and other forms of partnership.

Public Sector Comparator (PSC) A term for a costing of a conventional procurement that is no longer preferred in the official guidance. See also Conventional Procurement Option (CPO).

Pure Time Preference The preference for consumption now, rather than later.

R

Real Prices Pricesexpressed in real terms, that is after removing the effect of inflation. The nominal (i.e. cash) prices deflated by a general price index, for example CPI or GDP deflator, relative to a specified base year or base date.

Real Terms Similar to real prices. The value of expenditure at a specified general price level: that is a cash price or expenditure divided by a general price index.

Relative Price Effect The movement over time of a specific price index (such as construction prices) relative to a general price index (such as the GDP deflator).

Relevant Cost or Benefit All costs and benefits that can be affected by decisions and that are therefore related to the objectives and scope of the proposal in hand.

Required Rate of Return A target average rate of return for a public sector trading body, usually expressed, for central government bodies, as a return on the current cost value of total capital employed.

Resource Accounting is the accruals-based accounting system used to record expenditure in departmental accounts. It applies generally accepted accounting practice (GAAP) to departmental transactions.

Resource Accounting and Budgeting (RAB) is an accruals-based accounting and budgeting system used to plan, manage and control public expenditure. Accruals accounting measures resources as they are consumed rather than when the cash is paid. Resource and Capital Budgets are set in terms of accruals information. So for example the Resource Budget includes a charge for depreciation, a measure of the consumption or wearing out of capital assets.

Resource budget is the budget for current expenditure on an accruals basis. It is divided into resource DEL (which is a control total) and resource departmental AME (a planning total). (See Departmental Expenditure Limit (DEL), Annually Managed Expenditure (AME) and Capital Budget)

Resources/ Resource Cost Terms used in a variety of senses, according to context. In resource accounting, ‘resource costs’ are accruals accounting costs expressed in real terms. In economic analysis a distinction is sometimes drawn between ‘transfers’, such as social security payments and ‘resource costs’ which are payments for goods or services. In departments and agencies ‘resources’ is a term sometimes used to describe expenditure from their budgets, or sometimes requirements of staffing.

Revealed Preference The inference of willingness to pay for something which is non-marketed by examining consumer behaviour in a similar or related market.

Risk The likelihood, measured by its probability, that a particular event will occur.

Risk Register / Risk log A useful tool to identify, quantify and value the risks and uncertainties relating to a proposal.

S

Sensitivity Analysis Analysis of the effects on an appraisal outcome of varying the projected values of important variables.

Shadow Bid Model A model that provides a benchmark to confirm VFM and affordability by estimating what it will cost the private sector to bid for a particular project or service. Usually developed by financial advisers appointed to the project based on their knowledge and experience of what the private sector is likely to deliver.

Shadow Price The opportunity cost to society of participating in some form of economic activity. It is applied in circumstances where actual prices cannot be charged, or where prices do not reflect the true scarcity value of a good.

Social Benefit The total increase in the welfare of society from an activity - the sum of the benefit to the agent performing the action plus the benefit accruing to society as a result of the action.

Social Cost The total cost to society of an activity - the sum of the opportunity costs of the resources used by the agent carrying out the activity, plus any additional costs imposed on society from the activity.

Stated Preference Willingness to pay for something that is non-marketed, as derived from people’s responses to questions about preferences for various combinations of situations and/ or controlled discussion groups.

Strategic Outline Case (SOC) A brief and very preliminary business case that introduces the project concept, identifies key issues and contains initial broad considerations of potential value for money, affordability and achievability. Used as a basis for deciding whether to develop a more detailed business case. See also Outline Business Case and Full Business Case.

Status Quo Option See Do Nothing Option

Substitution The situation in which a firm substitutes one activity for a similar activity (such as recruiting a different job applicant) to take advantage of government assistance.

Switching Point or Switching Value The value of an uncertain cost or benefit at which the ranking of options switches from one option in favour of another.

Systematic Risk Risk that is correlated with movements in the economic cycle and cannot therefore be diversified away.

T

Time PreferenceRate Preference for consumption (or other costs or benefits) sooner rather than later, expressed as an annual percentage rate.

Total Economic Value The sum of the use, option and existence value of a good: a term used primarily in environmental economics.

Total Managed Expenditure (TME) The sum total of DEL plus AME. TME is a measure drawn from national accounts, representing the current and capital spending of the public sector. The public sector is made up of central government, local government and public corporations. See also Departmental Expenditure Limit (DEL) and Annually Managed Expenditure (AME).

Transfer Payment A transfer payment is one for which no good or service is obtained in return.

U

Uncertainty The condition in which there is a range of possible outcomes and it is impossible to attach probabilities to each of them.

Use Value Value of something which is non-marketed, determined by observing people’s actual use of it.

V

Viability A key criterion in cases of financial assistance to the non-government sectors. Project viability should be assessed to help ensure that public money is not wasted on projects that will fail prematurely e.g. there should be evidence of sound business planning in terms of reasonable cash flow projections and suitable arrangements for project planning, finance, marketing and management.

Value for Money (VFM) VFM means getting a good deal and is generally achieved when the ratio of benefit to cost is optimal for any given activity. VFM studies range from economic appraisals which assess costs and benefits from a national or regional perspective; to smaller scale measurements of economy, effectiveness or efficiency for particular activities. VFM in procurement is defined in Managing Public Money as “the optimum combination of whole-of-life costs and quality (or fitness for purpose) to meet the customer’s requirements.” The NI Procurement Board recently adopted the following definition of VFM in procurement: “the most advantageous combination of cost, quality and sustainability to meet customer requirements.”

W

Weighted Scoring Method A form of multi-criteria analysis that involves assigning weights to project objectives or more detailed performance criteria, and then scoring options in terms of how well they perform against those objectives/criteria. Weighted scores are then summed and used to rank options.

Willingness to Accept The amount that someone is willing to receive or accept to give up a good or service.

Willingness to Pay The amount that someone is willing to give up or pay to acquire a good or service.